Many simulated trading systems have been devised to give traders a feel for investing without actually taking on the risks of investing, thus contributing in some way to educating potential investors on investing and trading. Some simulated trading systems are strictly simulation systems, while others are contest systems.
In a simulation system, a participant opens a portfolio and enters trades for stocks and other securities. Those trades are not actually made on behalf of the participant and the participant need not put up funds to pay for the buy trades, however the participant might have to pay a membership fee. Typically, the system operator will simulate a nonzero amount of cash or equities in the portfolio so that the participant has “funds” with which to make buy trades or securities to “sell” to obtain funds for buy trades. The participant's trading is reflected in that participant's portfolio.
In a simulation system, the participant is not at risk for losses to the portfolio. The simulation system operator is also not at risk for the losses, because the trades are not actually made and the funds and the securities contained in the participant's portfolio do not actually have to be backed by the system operator, because the participant never withdraws or gets anything of value from the portfolio, other than an education about the process of investing. Prior to the widespread use of computer systems in simulation systems, an process analogous to interactive simulation of investment called “playing the market on paper” was done by many would-be investors to test their investing skills and to test theories of investment in a risk-free manner. For example, a paper market player might write down some securities and purported quantities and track the performance of the securities to assess performance over time. Note that, as with the simulated trading system described above, there is no risk to the participant because there are no actual investments.
Since there are no actual investments in a straight simulated trading system, there are no gains to be had by the participants, other than gains in understanding and the knowledge that one might have made a sum of money if the actual investments had been made. However, with no actual financial gain and possibly concluding that opportunities were missed when the paper portfolio does well, many potential investors and students of the investment process quickly lose interest in the straight simulated trading system.
Investment contest systems overcome the drawback of not having an upside for the participants. In a contest system, the system operator sets the rules for portfolios and trading and allows participants to set up portfolios, typically starting with an all-cash portfolio of a prespecified amount, and allows the participants to make trades on their portfolio. The trades are not actual trades, in that no shares are bought and sold, as is the case with the straight simulated trading system. The system operator offers prizes to the participants with the best performing portfolios, typically covering the costs of prizes as a promotional cost for other products or services provided by the system operator or their sponsors. For example, a newspaper might sponsor a stock picking contest with prizes in order to promote their newspaper as a source of stock quotes and financial information, or just to raise general awareness of the newspaper.
In a typical contest system, the system operator determines in advance the amount to put at risk by creating a rule that the top performer receives a predetermined sum of money, the second top performer receives a smaller predetermined sum of money, and so on. Thus, the system operator will know ahead of time what the total amount the operator has at risk, regardless of the actual performance of the participants or even the number of participants.
The typical contest system has limited usefulness as an investment education tool, since the optimal strategy for the participant is much different than an actual investor. For example, if an average investor has $10,000 to invest, the investor might allocate $2,000 to five different market sectors to diversify the portfolio. However, in a contest where the only winners are those that have performance exceeding nearly all the other contestants, a more suitable strategy would be to pick one stock that is likely to rise considerably throughout the contest duration. As would be expected, stock picking contest winners are usually the participants who bet heavily on one stock (or as few stocks as the contest rules allow) that rises. The prudent investor that also picked that stock, but diversified, would not be a contest winner except in the unlikely event that all of the several diversified stocks rose considerably.
Of course, there is a system wherein the participants benefit in proportion to their actual profits and has all the right characteristics for learning about actual investing—opening a brokerage account and making actual trades with real money. Of course, this would subject the investor with the full risk of mistakes made during the education process.
Heretofore, however, none of the various simulated trading or education systems have allowed for a user/student to make trades and keep all or a portion of the user's net profits without having put up funds to risk, thereby educating the would-be investor with incentives that are nearly the same as the incentives in an actual investment situation.